Larry Ribstein, a law professor at the University of Illinois, wears his hate for the Sarbanes-Oxley Act of 2002 on his sleeve. On his blog he sells a T-shirt featuring a clothes line clipped with two socks, one labelled Sarbanes, the other Oxley, with the caption âHanging business out to dry.â

WorldCom chief

Bernie Ebbers

Ribstein, co-author of The Sarbanes-Oxley Debacle, is not alone. Since the act was passed during a single frantic month in July 2002 at the height of the scandals at WorldCom, Enron and Tyco, the legislation has suffered the wrath of executives, directors, boards, auditors, bankers and lawyers, who all complain it was passed too quickly and that America might take decades to recover.

The prosecution case against Sarbanes-Oxley is extensive. Some argue it merely repeats older legislation: the US already had a thickly plated regulatory regime 70 years old in the Securities Exchange Act of 1934.

In addition there is the Foreign Corrupt Practices Act of 1977, which required companies to have internal controls over functions such as accounting. Other critics have gone further: they have argued that the act has eroded foreign competitiveness, that it imposes excessive costs, and leads to extra litigation.

President George Bush signed the act on July 30, 2002. And with the fifth anniversary just days away, it is as unpopular as ever. In December, New York Mayor Michael Bloomberg endorsed a report that predicted a loss of 60,000 jobs and $25bn (€18bn) in cashflow on Wall Street over five years unless Sarbanes-Oxley and other securities laws were revamped. Executive search firm Korn/Ferry found that 58% of US directors wanted to repeal the rules.

Yet supporters of the measures argue that blaming the act for all corporate America’s ills is unfair. In many circles, Sarbanes-Oxley has become a convenient shorthand for everything that is wrong with the US’s burdensome regulatory regime and even, in some cases, its controversial foreign policy.

Many issues have been laid at the act’s door which, on closer inspection, have nothing to do with the text or spirit of it. The effect of Sarbanes-Oxley is getting lost in translation, according to Harvey Goldschmid, a Columbia Law School professor and former Securities and Exchange commissioner.

“When I took office the day after Sarbanes-Oxley was signed, the markets were in turmoil and the business community in disrepute. Five years later, the atmosphere has dramatically improved and Sarbanes-Oxley gets a good deal of credit for the change,” said Goldschmid.

A desire to legislate is a long tradition for the country. The act’s critics said America’s love for the precision of the written word was one of the reasons the act was passed. Whereas the UK gets by without a constitution, in America there is a love of codifying, classifying and sanctioning everything that moves.

Nowhere is that more true than in financial regulation, where the UK depends on principles and the US depends on multiple layers of oversight. It spends more than $425,000 on this for every $1bn of gross domestic product, according to Harvard Law professor Howell Jackson.

Much of the charge sheet against the Sarbanes-Oxley Act does not add up. Of all the allegations against it, it is the claim that the act has eroded America’s competitiveness that has had the most resonance throughout the country’s boardrooms. The act is blamed for the US becoming less competitive with foreign markets, especially when it comes to listings of initial public offerings.

But Hal Scott, a Harvard Law professor and director of the committee on capital markets regulation, backed by US Treasury Secretary Henry Paulson, said nothing in the act was prohibitive to foreign firms, and that the committee had been careful not to lay the blame on Sarbanes-Oxley for US competitiveness problems.

“The drive to the private market and the growth of foreign markets are not the fault of Sarbanes-Oxley,” said Scott. He cited two big problems with the US markets that affected competitiveness.

The first was litigation and the second was “the way the SEC goes about doing its business. It doesn’t particularly care whether people want to come to the US or not. The SEC defines its mission simply as the cop on the beat. But in a competitive world, we need to compete and stay ahead.”

Ethiopis Tafara, director of international affairs at the SEC, recently said: “US markets have not become less competitive. They are facing more competition.”

The allegation that the act has led to a decline in the number and value of listings is difficult to sustain, because other countries sustained similar declines. It is true that after 2002 fewer US firms went public – but UK firms also shied away from listings.

Ken Lehn, a professor at University of Pittsburgh, found that about 87% of US IPOs since 1990 took place before Sarbanes-Oxley, and 75% of the dollar volume of US IPOs was raised before the legislation. But in the UK similarly, most IPOs took place before 2002: 68%, and 75% of UK listing proceeds were raised before the act.

Many of the changes in foreign listings appear to be either cyclical or political. Last year, almost all of the of the top-10 largest IPOs were privatisations of state-owned firms, especially in China. And the number of first-time American Depositary Receipts listed in the US was falling as long ago as 2000, two years before the act, when there were 53 ADRs listed worth $46.39bn. The next year, there were only eight, worth just over $7bn, according to data provider Dealogic.

And the pendulum is swinging back to the US: by last year, there were the same number of ADRs listed, 17, as there were in 1998. Similarly, last year there were 41 IPOs from non-US issuers in the US – the highest number since the pre-Sarbanes-Oxley days of 2001.

There is other evidence the act suffers mainly from a perception problem. A Korn/Ferry study this year found that 72% of directors in the Americas felt their boards had become more cautious because of Sarbanes-Oxley. However, 61% of the boards in the UK felt the Combined Code had the same effect. Yet 58% of the directors in the Americas thought the act should be repealed or overhauled, while only 28% of the directors in the UK felt the same about the code.

Lewis Ferguson, partner at law firm Gibson Dunn & Crutcher and former Public Company Accounting Oversight Board general counsel, said the requirements of the act were similar to those of many foreign regulators, including the UK’s Financial Services Authority and the French, Canadian and German regimes. He said: “Most of that has been adopted since Sarbox. We were the first people to put in a system of periodic inspection.”

And the differences were decreasing every day. Tafara and SEC international affairs senior counsel Robert Peterson have drawn a blueprint for international regulatory co-operation, and the introduction of International Financial Reporting Standards will draw many international regulatory regimes closer together.

So arguments that Sarbanes-Oxley has substantially added to the US regulatory burden look difficult to stand up. But what about the charge that the act has imposed excessive cost on the industry?

Small companies would suffer that cost more than their large competitors. But more than 6,000 small companies, with a market capitalisation of less than $75m, have been exempted from Sarbanes-Oxley for the past five years. They will not have to file a year-end internal control reports until next year, or an external auditor’s report until early 2009.

German chemicals producer BASF puts its Sarbanes-Oxley costs at between $30m and $40m a year, as does General Electric. In 2004, former AIG chairman Maurice Greenberg estimated the company spent $300m a year fulfilling the requirements.

Yet studies suggest companies have earned back those costs, thanks to a rising stock price that can be directly attributed to complying with the act. Lehn’s research found that because those US companies have avoided risky activities over recent years, that has produced an instant share price premium of almost 30% for all companies listed in the US.

Steve Wagner, head of Deloitte’s corporate governance centre, said the companies that faced the high cost of compliance were making up for slack before. “It does surprise me when costs are up in the stratosphere, and it indicates they had a high degree of deferred maintenance,” he said.

Accountancy firm PwC found in 2005 that more than 54% of 341 companies with more than $150m in revenues foresaw no more increases in their Sarbanes-Oxley-related spending, while 7% expected the costs to decrease over two years.

Lee Dittmar, leader of Deloitte’s governance risk and compliance consulting practice and co-head of its Sarbanes-Oxley services group, said: “This first five years have been messy but, remember, we have been moving an entire financial ecosystem to a different plane than it was before.”

Dittmar and Wagner wrote: “Fear can be a powerful generator of upstanding conduct. But business runs on discovering and creating value. The procrastinators need to start viewing the Sarbanes-Oxley Act of 2002 as an ally in that effort.”

The act’s supporters, including former WorldCom trustee Richard Breeden and Republican Congressman Michael Oxley, who sponsored the act and is now at Nasdaq, urge another perspective. “The implementation costs are one-ten-millionth of executive pay,” Breeden said.

Because Sarbanes-Oxley imposes big fines on corporate fraudsters, it is easy to blame it for the multibillion-dollar class-action settlements crowding the markets. But a closer reading reveals that nearly all of that litigation is based on other rules in the US regulatory system, particularly Rule 10b5 of the Securities Exchange Act 1934, which prohibits fraud and deceit in securities transactions.

In addition, class-action lawsuits have been falling, not rising. In the first half of this year, the number of class-action lawsuits filed fell 42% from the average six-monthly rate of 101 cases to 52 cases, according to Cornerstone Research. While the number of class-action settlements rose fivefold last year, that was largely due to 14 mega-settlements from 2002 and 2003, including the $6.6bn partial settlement of Enron.

Mary Jo White, a former US federal prosecutor who is now with law firm Debevoise & Plimpton, said no big shareholder lawsuits had been closely influenced by Sarbanes-Oxley. The US courts have come down against big shareholder lawsuits, most recently in the Supreme Court’s rejection of an IPO antitrust lawsuit against Wall Street underwriters. And the Committee on Capital Markets Regulation has called for Rule 10b5 to be amended.

So the charge sheet against Sarbanes-Oxley, although long, is open to question. Nevertheless there are still attempts to revise the act, including an amendment of the controversial auditing standards and the Treasury Secretary’s task force to revamp the US regulatory regime.

Paulson pledged to devote the next six months to creating a blueprint for modernising the regulatory structure in the US. He said he would create two panels, one representing investors and the other managers of money and companies.

The SEC and Public Company Accounting Oversight Board have revamped Section 404 to allow outside auditors to take on the work of internal auditing staff. The committee, like the European Union’s internal market commissioner Charlie McCreevy, has also asked for a cap on liabilities for auditors.

Corporate America has come to terms with the Sarbanes-Oxley Act, and even its greatest critics are beginning to admit that not all the country’s evils should be laid at its door. The charge against the act has been that it has led to the decline, both in performance and morale, of corporate America. Guilt, but only by association, is becoming the apparent verdict.

The controversial clauses

Amid the complaints about cost, foreign competitiveness and potential legislation, only three main parts of the act have drawn fire: Sections 302, 404 and 906.

• Section 302 calls for chief executives and chief financial officers to sign off on financial statements and auditing controls.

• Section 906 imposes potential penalties of $5m (€3.7m) and 20 years imprisonment if the companies do not comply.

• Section 404, the most notorious,a mere 173 words long, only asks companies to submit full reports of internal controls every year. However, this has created havoc as companies struggle to interpret how far they have to go to comply. It has taken five years for the US Securities and Exchange Commission and Public Company Accounting Oversight Board to provide clearer expectations for auditors about how to comply with the section.